How much life insurance do you really need? It takes a few steps to calculate, but it’s not rocket science. The only thing that really matters when it comes to determining how much life insurance you need, is how much income do your dependents need if you aren’t around? To answer this you have to first answer these two questions;
- how much do you spend each month? (Use your bank statements to calculate your monthly average spending) and
- do you have any realisable investments or assets other than that marked for retirement or future know expenses like kids education?
A working example to calculate your insurance needs…. Let’s say you know you spend $6,000 each month to pay all your bills including your debt repayments. Of the $6,000, you earn $3,500 and your partner earns $2,500. Your monthly income is equivalent to $42,000 a year ($3,500 x 12). You need enough protection insurance so that if you pass away, you could invest the proceeds and earn $42,000 after tax. How do you calculate that? If you assume you could earn 5% on the money, simply divide $42,000 by 5% and you have your answer. In this example, the number is $840,000 (42,000 / 0.05). That’s how much savings you need to invest at 5% to earn $42,000. The $840,000 is what your survivors need to get through until they don’t need your income. You can offset it with other insurance you already carry or if you have savings or realizable assets that isn’t earmarked for retirement or other purposes. This isn’t a scientific approach – it’s a ballpark calculation. But it’s pretty close to what you need, and it’s a calculation you can do yourself. It’s also a heck of a lot better than a wild guess.